Welcome to the Million Dollar Journey March 2015 Net Worth Update – Team MDJ edition. A select group of readers were selected to be part of Team MDJ which was conceived after the million dollar net worth milestone was achieved in June 2014. Karl the Real Estate Agent was selected as a team member and will post net worth updates on a quarterly basis. Here is more about Karl.

Notes: Almost all of net worth is in the real estate market (principal residence and rentals). Current debts are $13,000 owing on a 2009 Audi a4, line of credit used to float business expenses. ($10,000)

The last few months have been great for us. My wife and I have really got on the same page which I feel is going to be invaluable in helping me reach my goals.

I’ve been struggling with which approach I’m going to take and I have decided right or wrong for me the biggest motivator right now if paying off my principle mortgage. I know this will rub a lot of people the wrong way as its the never ending argument which is best – debt reduction vs investing.

My focus going forward will be to sell my real estate holdings except the one rental my wife and I hold personally and throw everything at the mortgage on our home. It’s our goal to be mortgage free. This means that we will need to make the sacrifices as a household to reach my goal of being mortgage free by 36.

Notable Changes Since Last Update

Purchased building lot and sold it. It should be closing in the coming months.

In the process of selling rental property.

My wife is onboard with paying down the mortgage on our house as aggressively as possible (huge motivator for her).

Made my first frugal move and cancelled cable and bought an android TV box. We will save $120/month which will help fund my wifes TFSA.

Any cash I have in my chequing account is currently used to pay monthly bills and living expenses. I deposit all my earnings directly to my Manulife One account. Manulife One Account has been cancelled. All paycheques are deposited into our chequing account and is our primary household account that everything runs through so the cash amount fluctuates.

Savings

My savings are held in a Tax Free Savings Account (TFSA) with BMO. I’m currently maxing out my TFSA and hope to do the same with my wife’s account by the end of the first quarter of 2015.

Where Do the Savings Come From?

I’m not a great budgeter or saver yet, so the bulk of my savings are in debt reduction to cover investments I have already purchased. (Typically land and investment properties) I find that working from behind is the best motivator for me.

Real Estate

My real estate holdings consist of my primary residence, 2 rentals and now one piece of development land. One owned personally and one held in a corporation with 2 other family members and one held in a partnership. I’m currently in the process of securing a building lot to build and sell a spec home on. Building lot has been purchased and resold and should be closed in the coming months, I’m also selling the rental held in the corporation with family members and that should be gone by mid 2015). On my initial post everyone expressed massive concerns about all of my holdings being in real estate and I have listened.

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Personally, I think your choice is the right one. Deleveraging your equity exposure and paying down debt is a smart choice. It will be interesting to see your networth in the next quarter. If you have valued your building lot and rental property incorrectly, it will show up as a big hit or big bump to your net worth. You’ll definitely need to bump up the rent. You should be pulling in at least 1% of the current value of the house in gross income every month, and it looks like you’re almost less than 0.5%.

My suspicion is they are recently married, as in < 3 years. It's not unheard of to spend a couple years immediately after marriage finding goals you both are truly aligned on, especially with regards to career and finances.

If consensus is challenging after 4 or 5 years, your chance of making to beyond 8 years 'happily' are not good.

I strongly disagree with the sale of the properties. I myself own 4 properties and my net worth has been growing at a fantastic rate. I think selling the vacant lot is a good idea, but not the rentals. From my experiance nothing compares to the profits I see from my properties. When I take my small profit and add it to the mortgage pay down, it is fairly common to see an annual return anywhere between 15-25% depending on the properties. I find people who have not owned rentals have a hard time grasping how beneficial they truely are. I am actually currently exploring a fifth property which will have an average income of roughly $24,000 and push my total rental income towards $115,000 annually.

You are to heavily based in real estate right now. But selling your rentals is not the answer, if they are profitable, DO NOT SELL!!! If you use the money from the sale of your vacant land to pay your mortgage and increase investments in RRSPs/TFSA etc. you will be in good shape. Real Estate is long term, but rentals pay off as long as you keep the property in good shape and screen tenants as much as possible.

I am also currently trying to pay down my own mortgage as quickly as possible and I think it is a great idea for you.

The rental I sold was held jointly with family members and was under a corp so once the decision was made that we weren’t going to be acquiring anymore properties due to the current low cap rates it didn’t make any sense to pay the accounting every year on the corp if it only had one property.

Can you not use your corp to split income between you and your wife? There is a big difference in your tax brackets, splitting income could help reduce the tax bill and put even more money into your mortgage.

I see someone not diversified, and very low on liquid assets. I would sell some of the properties and research other investments. When the real estate market declines in your area, not only will your properties lose value, but your income will be affected.

Nobeleea,
Pulling in 1%+ of current property value in gross monthly rent: e.g. $5,000 per month for a $500,000 property? Unless you’re talking about a rooming house or out of favour rental market, which will push up the cap rate, I don’t know how else you can achieve that. Karl’s 0.5% and lower, is realistic as far as I’m concerned in a seller’s market.

What are the reasons you chose the mortgage route over the investment route for your money?

For the last five years my mortgage has been ~2% and even though I could have paid off my mortgage (and still could), it made no sense to secure a 2% “return” via debt when the same money allocated to investments has provided far superior real returns (with no sleep lost).

Makes even more sense when you consider your primary residence to be a long-term expense on a depreciating asset (which it is) rather than a true investment in production. And even moreso now that rates have dropped even further.

All you have to do is take a look at what corporations have been doing since the financial crisis — taking out lots of (very) low interest loans and using the money to buy stuff. They are taking on more and more debt and making a killing by NOT paying off their low interest loans.

I agree with Ed Rempel in that Canadians have a weird fixation with paying off mortgages (notice how many MDJs here are built on a singular pillar — “mortgage free”?), even though at the same time they have collectively pushed their other high(er) interest rate debt levels to ongoing all-time highs. In other words, Canadians have their financial priorities completely backwards.

Have to agree with SST (and Ed Rempel if he shows up) — putting all your extra money into a 2% investment is not the best move.
I’m not sure if it’s a very Canadian thing or not, but it really makes no sense in your case.

As an interesting alternative to the 2% mortgage, consider the biotech index IBB.
Trades at about 23 times earnings and has had an average return of about 30% per year over the bull market.
30% per year on profitable biotech with a small dividend. Look at Amgen as an example holding.
Anyway, at your young age I would consider something like this in my portfolio. Although you missed a hell of a run, along with other mortgage-first folks.

The number is correct. It’s a long term average. It just means that income properties are being priced too high. Either rents go up or prices go down.

RE the mortgage interest rate comments. When you prepay your mortgage, you’re not really saving your current mortgage rate (unless you pay it off this term). You’re saving the rate during the term that you pay it off. Since we’re at historical lows, it’s likely that your aggregate rate saved is going to be higher. Plus a guaranteed return. Some might think of it as your fixed income investment.

It’s dangerous to downplay the benefit of paying off a 2-3% mortgage. Stocks can go down. A Positive 3% guaranteed after tax return is pretty damn good in comparison to an uncertain future event. Also, when rates rise and you’ve kept your mortgage high, suddenly that mortgage becomes a beast. Kill it while it’s sleeping.

It took about 45 years for mortgages rates to go from 5% to 20%, and about 35 years for rates to go from 20% to 2% (with the average being ~8%).

You cannot ignore the present low-rate environment in fear of “an uncertain future event”. The future event is quite certain — rates will rise. Will they rise faster or slower than the historical 0.3% per year average? When will they rise? Next year? In five years? Never? Perhaps rates will decline even further.

The average rate for your entire 25-year mortgage might be 7%.

Apply this 7% total rate to the $250,000 mortgage and your total interest payments are ~$275,000.

But you will never actually “save” this much unless you pay off your mortgage on Day 1. As well, if the rates are only bound to rise, then you’ll be paying higher rates on lesser amounts as you pay down the mortgage naturally. (In other words, a more complex adding machine is needed to attain a truer estimate).

Now let’s say instead of paying off your mortgage you invest that $250,000 on Day 1 in the stock market. With 25-year median returns of 13%, at the end of the term your portfolio has a value of $5.3 million.

But wait, you say! What if the mortgage free you applies the previous mortgage payment to investments over the next 25-years, how much would you make? $3.7 million is your answer.

Knock out the $275k of interest payment, and adopting an oh-so Canadian ‘mortgage free’ bias costs you over a million dollars (in this example).

A couple thoughts on the mortgage paydown question. Rates are very low now and there are some powerful forces, such as demographics, technology and globalization, that may keep them low for a long time.

The chance that a stock market investment will outperform your mortgage rate over the long term is very high. The worst 25-year period in the last 150 years for the S&P500 was a gain of 5%/year, which would easily beat your mortgage rate. Over 30-year periods, stocks beat bonds (which are usually similar rates to mortgages) 100% of the time.

The other point is that your financial future may well be more at risk by paying off your mortgage. An important study by 2 Yale professors called “Lifecycle Investing” is very relevant here. It shows that one of the biggest risks in achieving financial independence by retirement is “last decade risk”.

If you invest a constant dollar amount for 40 years and look at the average investments in each year, 2/3 of your investment holdings over the 40 years are in the last 10 years. That means your return over the 40 years is almost entirely determined by the return those last 10 years.

The solution they recommend is leverage for young people in their 20s and 30s into equities in order to diversify across time. Then the leverage is paid starting in their 40s.

My point is that by focusing on your mortgage today, you increase your “last decade risk”. Your lifetime financial security is even more based on whatever your return happens to be the last 10 years before you retire.

One last point, Karl. You are still not diversified and almost entirely real estate. You were $900K real estate to $20K other. Now you will be $700K to $20K other. You went from 98% real estate to 97% real estate. If there is a real estate crash, you are very vulnerable.

SST: Saying you would invest the $250,000 from Day 1 doesn’t really work. The whole idea behind a mortgage is that one does not have the $250,000 and pays it down over a long period of time. So the 5.3 million calculation doesn’t really add up.

In reality if you do not pay down your mortgage and invest the money instead, you would only be investing the prepayment amount, not the entire value of the mortgage, since you still make minimum payments on your mortgage.

Ie. if your yearly pre-payment amount is $5,000 and you invest this yearly you would end up ay $880,000 at 13% over 25years

$5,000 a year on a 25 year mortgage at 7% knocks about 9 years off the mortgage

Not saying it’s a bad idea not to pay your mortgage down, just your estimates were rather inflated.

If mortgage rates were 7%, or expected to be within any reasonable time frame (don’t forget global economic realities, as Ed mentioned), then I would be throwing in a significant chunk of my discretionary savings into the house.

As it is, better to take the higher returns now (yes, 30% annual for the last 5 years on IBB) and move some of that to the mortgage if and when rates go up from 2-3%.

@Mikek: you need to go back and re-read the OP’s upcoming strategy — “throw everything at the mortgage on our home”.

He will have $150,000, more or less, available for immediate allocation, and he’s putting it on his mortgage instead of into other assets (e.g. stocks). He will also allocate ~$100,000 over the next three years to his mortgage. A standard payment route might require $25,000 or less over the same time period.

What if he allocated the same amounts, $150,000 + $35,000*3, to stocks (or any other investment asset) instead of his mortgage? His interest savings will be far below any gains from investments. (And, no, my estimates were not inflated. As previously questioned, no one does math any more?).

I’ll use myself as an example: I have the means to pay off my mortgage in its entirety but I chose to invest that amount into other assets. I’m seeing very, very healthy double digit returns on that money as opposed to a guaranteed aggregate ~3% (which is also something that people don’t really understand). In another 20 years I’m confident that initial amount, allocated to other assets, will provide much greater wealth than if I had paid off my mortgage.

The “guaranteed return”, using my example in #18, is $275,000 (it’ll probably be less because I used a pretty high rate). But that’s over 25 years. Once he pays off his mortgage he doesn’t automatically get a $275,000 “savings” cheque in-hand. So his “guaranteed return” is now not only spread across 25-years but the rate is locked-in and subject to inflation erosion — the fabulous guaranteed return has already been gobbled up by inflation! His allocation will also be locked-in to an extremely localized position; considering his income is generated and effected by the same local forces, perhaps not a great idea. (Yes, I understand one has to live somewhere, but one does not have to put all their money all at once into one geographic point.)

Put another way, would you put 50% of your net worth into a 3% long-term bond right now? I sure wouldn’t. But then again, maybe I’m not Canadian enough.

Perhaps it’s a misunderstanding of holding debt scaring people into short-term tunnel vision which leads to actions such as throwing everything at the mortgage, and blinding them to actual wealth building opportunites.

When I was an “all in mortgage” guy, I felt that paying it off would be some great accomplishment, something really impressive. This allowed me to ignore what I knew were the better expected returns on other investments. Certainly I also had some degree of fear of stocks in particular. (Which is healthy!)

I know that it’s easier to become rich by thinking like an emotion-less, rational psychopath than an emotionally driven human being. And for many people, at least in theory, more money = better. However, there’s two factors that the pro-stock market for higher returns thinkers are not factoring in, specifically for Karl and his wife. Karl and his wife are not historically as good at saving money as they would like to be. Obviously, there is a real estate investing bias in that household. If Karl and wife are investing, like many of you suggest, into stocks, the emotional factor makes it more difficult than you give credit for. They are not as emotionally motivated to be frugal and better savers if their money is being invested in the stock market compared to the enthusiasm and reward that they get from working towards paying down their mortgage. Also, as many of you know, emotional investing in the stock market can have dire consequences. So my point is that if they invest in the stock market, they might end up saving less money per month to put in that pot because they are not as emotionally attached to that goal (regardless if it’s a path to greater wealth). Yes, I know that even if they save 75% as much because they don’t like the strategy as much, they may still come out ahead investing in the stock market.

Secondly, they are hoping to be mortgage-free in 3 years. Besides the higher savings per month that brings, in 3 years, their level of happiness and feeling of accomplishment would be huge, if it’s paid off. If they don’t have that, they could be unhappy for several years, regardless if their net worth is growing more quickly.

I think people need to pick their battles. And I think they’ve chosen wisely. They will be happier going down the path that they chose. And you can’t put a price on happiness.

That being said, I have no interest personally in being mortgage-free. I don’t currently, but will eventually do the smith manoeuvre and take advantage of low interest debt as much as possible to gain higher returns elsewhere. That makes me happy. I’m not afraid of good debt.

I think that Karl was descriptive enough about how he felt about this strategy for him and his wife for us to understand that this is what will work for them specifically. He never said that this is universally a good strategy or that it would work for anyone else. To each their own.

Not sure why you bought the ‘development land’ in 2015 and are now planning to sell it? Was that a mistake? Of course with transaction fees, tax, legal fees it does not make sense?

I am also in the do not pay off the mortgage as it makes no sense with these low interest rates and much better returns many other places. In fact it will be an ongoing financial loss paying off the mortgage quickly when you can make more money investing in ETFs. Paying off the mortgage is an emotional choice not a financial choice.

@R: you’ve just illustrated why so many people are terrible with money — emotions. Yes, we are all emotion driven: fear and greed. The thing is, to be successful with money, one needs to learn to detach from, or at least control their emotions and biases.

To point this out, you state: “their level of happiness and feeling of accomplishment would be huge, if it’s paid off. They will be happier going down the path that they chose.”

But that path is very short-term. They have chosen to fulfill a short-term financial goal that, as Ed pointed out in #19, could possibly have a big negative impact on their long-term financial goal. Think their mortgage-free happiness will still be with them in 30 years if they have to work an extra 5+ years to fulfill their long-term financial goals?
(FYI, event-happiness/sadness dissipates within months.)

The OP even admits: “I’ve been struggling with which approach I’m going to take and I have decided right or wrong for me the biggest motivator right now if paying off my principle mortgage.”

If his decisions have been a struggle and if he still doesn’t even know if those decisions are “right or wrong”…then why is he taking action?!

I wonder if he’s ever truly questioned why being mortgage-free is of such high importance to him and what is the true long-term potential benefit, stand-alone and vs. other strategies.

Money is merely a tool used to build the life you want. People very often are not skilled at using that particular tool and therefore very often end up with lives much different from imagined.

With a gross income of ~$195,000, hopefully the household should be able to pay off the mortgage in 2 years, by the time Karl is 35.

I’ll assume at that time his rental property will be worth $255,000 + $30,000 in savings. His net worth will be ~$300,000.

(notes: i) I boosted his savings & final NW, ii) discounted the rental mortgage assuming rent will cover those costs for the duration, iii) excluded principle residence from NW for a lot of reasons.)

Karl will now have ~5 years to build up $700,000 of wealth.
If the household net income is ~140,000 and they manage to save 50% of that every year, they will need to make ~25% annual returns on their money to become millionaires by 40. Not likely to happen.
It will take $100,000/yr @12% to achieve the desired NW. Can the household learn to become great budgeters and savers?

Which brings me to my second point in which Karl states: “It’s our goal to be mortgage free. This means that we will need to make the sacrifices…”

Biases create limitations. Karl views “sacrifices” as expenditures from income; he sees what he will have to give up during his journey to his goal of being mortgage free (e.g. cable TV). What he misses is what is being sacrificed after his goal is met by choosing that specific goal (e.g. higher long-term returns). He might acheive his short-term goal of being mortgage free but at the same time sacrificing his shortish-term goal of attaing a million dollar net worth.

My suggestion to Karl would be to rip apart your game plan and re-examine it from every angle, really define what your true goals are and if reality (aka math) supports those goals.

(As an aside, I was probably the only one in Karl’s initial posting who suggested he go all-in with real estate. So much for the voice of one. ;) )

When your marginal tax rate is nearly 50%, that 2% return on having the low-rate morgate paid off is equivalent to a 4% investment return (pre-tax).

Now that 2% is a guarenteed return if you’re fixed rate, and you certainly can’t get 4% return in the market guarenteed.

If you are variable, there is risk that rates will go even lower in the short term but everyone seems to agree rates will rise in the mid-term.

If you pay of your mortgage now, rather than later when interest rates rise to say, 5%, that 4% return becomes a minimum (now), with upside potential to become 10% at when your mortgagte rate would hit 5%.

Another point of consideration is this ROI from paying down debt results in immediate positive impact on free cash flow. You aren’t getting some other asset (like an unrealized capital gain) as the return, you’re getting a constant supply of cash from not paying the interest.

Obviously if you are in a low tax bracket, this effective pre-tax return isn’t nearly as attractive.

Capital is rare. Capital should be put to use to make money. I have a large mortgage on my house (HELOC style), and 1-2 times a year when a portion has been paid down I will access the funds and invest them. If interest rates were high, I would likely not do this.

Right now my mortgage rate is 2.2%, and I am able to get 8% and sometimes 10% with the funds. So for me it makes sense to forgo the guaranteed return of %4.4 by paying down my mortgage, and instead use the funds to generate 8-10% pre-tax returns.